Financial Services Posted on October 03 2010by 2010 by Farhad
FINANCIAL SERVICES TEXT BOOKS TO BE FOLLOWED For Unit – II: Khan.M.Y., 2006, Financial Services, 3rd edition, TMH, New Delhi-8 For Unit – III & IV: Gordon and Natarajan, 2006, Financial Markets and Services, 3rd edition,
Himalaya publishing House, Mumbai. For Unit – IV: Rejda.G.e., 2002, Principles of Risk Management and Insurance, 7th edition, Pearson Education BEST BOOK FOR ALL UNITS – FINANCIAL SERVICES BY GURUSAMY OR MERCHANT BANKING AND FINANCIAL SERVICES BY GURUSAMY. Both the books have same content and you can take any one for your reading.
UNIT-I
Financial services:Concept and meaning. Classification – Traditional and Modern activities; Fund-based and nonfund based activities. Financial Engineering – Need for financial innovation; Model for new product development; new financial products and services. Current scenario and challenges to the financial services sector in India. 1
FINANCIAL SYSTEM
The economic development of any country depends on the existence of a well organized Financial System (F.S). It is the F.S which supplies the necessary financial inputs for the production of goods and services, which in turn promote the well being and standard of living of the people of the country. Thus, the F.S is a broader term which brings under its fold the financial markets and the financial institutions which supports the system The F.S comprises a variety of intermediary, markets and instruments that are shown in above diagram. It provides the main means by which savings are transformed into investments. Given its role in the allocation of resources, the efficient functioning of F.S is critical to a modern economy. The economic development of a nation is reflected with the progress of various economic units, broadly classified into corporate sector, Govt. and Household sector. While the corporate has the surplus arising from the retained earnings, they need funds for investment in new projects, for expansion/Diversification/modernization, etc. On the other hand, a Govt. which always faces a deficit budget needs funds for public expenditure to finance its
developmental projects and other Public Sector Undertakings (PSUs), etc. along with these two economic units, the household sector requires funds for varied purposes. Example, for acquiring assets. How ever the surplus funds of the household is normally more than the other units. While an understanding of the financial system is useful to all informed citizen, it is particularly relevant to the financial manager. He negotiates loans from financial intermediaries, raises resources from the financial markets and invests surplus funds in financial instruments. In a very significant way he manages the interface between the firm and its financial environment. 2
An overview of Financial Service (F.Sr)
Financial services constitute an important component of the F.S. F.Sr through the network of elements such as financial institutions, financial markets and financial instruments serve the need of individuals, institutions and corporates. It is through these elements that the functioning of the F.Sr is facilitated. In fact, an orderly functioning of the F.S depends to a great deal on the range and the quality of the F.Sr extended by the host of providers. Concept of Financial Services
In general, services that are offered by the financial service companies are said to F.Services. The term “Financial services” in a broad sense means “mobilizing and allocating savings”. Thus, it includes all activities involved in the transformation of saving into investment. Financial Service companies include both Asset Management Companies (AMC) and Liability Management Companies (LMC). AMC include leasing companies, Mutual Funds, Merchant Bankers and Issue/Portfolio managers. LMC comprise of the Bill Discounting and Acceptance Houses. Objectives of Financial Services
– Financial Services help to raise required fund from a host of investors, 1. Fund Raising – Financial individuals, institutes and corporate. – An array (variety/types/collection/group) of financial services are 2. Funds Deployment – An available in the market which helps the players to ensure an effective deployment of the funds raised. Services such as Bills Discounting, Factoring of debtors, parking of short term funds in the money market, credit rating, etc. are provided by financial services firms in order top ensure efficient management of funds. – The financial services sector provides specialized services such as 3. Specialized services – The credit rating, venture capital financial, lease financing, factoring, mutual funds, merchant banking, credit cards, housing finance, etc. besides banking and insurance. – In India, Agencies such as Securities and Exchange Board of India (SEBI), 4. Regulation – In RBI and the Dept. of Banking and Insurance of the Govt. of India, through a number of legislations regulate the functioning of the financial services institutions.
5. Economic Growth – Financial services help in speeding up the process of economics growth and development. This takes place through the mobilization of the savings of a cross section of peoples, for the purpose of channeling then in the productive investments. 3
FINANCIAL ENGINEERING
Financial Engineering (F.E) is the development and application of financial technology to solve financial problems and the creation of value by the identification and exploitation of financial opportunities. The term F.E means different things to different people. F.E involves the design, the development and the implementation of innovative financial instruments and processes, and the formulation of the creative solutions to the problems in finance. In corporate finance, the financial engineers are often called upon to develop new instruments to secure the funds necessary for the operation of large scale businesses. Financial Innovation
Miller describes financial innovations as unanticipated improvements in the array of financial products and instruments that are stimulated by unexpected tax or regulatory impulses. Silber considers financial innovation as devices used by companies to reduce the financial constraints faced by them A financial innovation makes the market more efficient if it reduces transaction costs, diminishes Van Horne losses, etc, 1
Financial Innovation in India
Till the mid 1980s, the Indian financial system did not see much innovation. In the last 18 years, financial innovation in India has picked up and it is expected to grow in the years to come, as a more liberalized environment affords greater scope for financial innovation. The important financial innovation that have taken place in India are listed below along with the principal factor which motivated it or fuelled its growth. New financial products and services services are as follows Innovation 1. Debt oriented schemes of MF 2. Partially convertible debentures and fully convertible debentures 3. Deep discount/zero coupon bonds 4. Puttable and callable bonds 5. Stock index futures
Principle motivation factor Tax Benefits Pricing and interest rate regulation obtaining under the capital issues control act Tax benefits Perceived volatility of interest rates Volatility Volatilit y of equity prices
6. Badla Transaction 7. Ready forwards 8. Havala transactions 9. Interest rate Caps/floors/Collars Caps/floors/C ollars 10. Interest rate swaps 11. Currency swaps 12. Forward rate agreements 13. Automated teller machine 14. Screen based trading 15. Floating rate bonds 16. Electronic funds transfer 17. Money market mutual funds 18. Specialized Mutual Funds 19. Exchange traded options 20. Project finance
Restriction on forward trading Restrictions under the portfolio management scheme RBI restrictions Volatility Volatilit y of interest rates Volatility Volatilit y of interest rates Volatility Volatilit y of foreign exchange rates Volatility Volatilit y of interest rates Technology Technology Volatility Volatilit y of interest rates Technology Volatility Volatilit y of interest rates Investor preferences Volatility Volatilit y of Stock prices Risk Sharing
Source 1. Prasanna Chandra, 2006, Financial Management, TMH 2. Gurusamy, Merchant Banking and Financial Services, Thomson publication 3. Marshall and Bansal, Financial Engineering, PHI
Unit I http://finance.wharton.upenn.edu/~allenf/download/Vita/indias%20financial%20system.pdf BEST http://www.indianmba.com/Faculty_Column/FC177/fc177.html – BEST http://www.indiaonestop.com/fdi-financial-services.htm http://ww.doleta.gov/Brg/pdf/Financial.pdf – http://ww.doleta.gov/Brg/pdf/Financial.pdf – General General knowledge – Informative http://www.profinvest.com.au/resources/files/pis_financial_services_guide.pdf – Informative – Outsourcing F.Ser http://www.bis.org/publ/ http://www.bis.o rg/publ/joint09.pdf joint09.pdf – Outsourcing http://www.munichre-foundation.org/NR/rdonlyres/9488227A-EFC0-4D46-89482615019A6FEE/0/Innovative_Financial_Services_for_Rural_India.pdf – F.Ser – F.Ser Rural India http://www.deloitte.com/assets/DcomIndia/Local%20Assets/Documents/Global%20economic%20slowdownFinancial%20Services.pdf – Financial%20Services.pdf – Indian Indian Financial Services and Financial Crisis http://www.deloitte.com/assets/Dcom – Impact India/Local%20Assets/Documents/a%20Global%20Financial%20Crisis.pdf Financial Crisis http://www.ibef.org/industry/financialservices.aspx – General – General information – GOOD http://en.wikipedia.org/wiki/Financial_services – GOOD http://www.surfindia.com/financial-services/
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UNIT – II
Merchant Banking:Concept and evolution of merchant banking (MB) in India. SEBI (MB) Regulations, 1992. Functions of MBs – underwriter, banker, broker, registrar, debenture trustee and portfolio manager. MBs’ activities and SEBI guidelines related to issue management.
MERCHANT BANKING The word “Merchant Banking” originated among the Dutch and the Scottish traders, and was later on developed and professionalised in Britain.
Though Merchant banking is a non banking financial activity, it resembles banking function. DEFINITION
According to Random House Dictionary, “Merchant bank is an organisation that underwrites securities for corporations, advises such clients on mergers and is involved in the ownership of commercial ventures. These organisations are some banks which are not merchants and sometimes merchants who are not banks and sometimes houses which are neither merchants not banks.” MERCHANT BANKERS
A set of financial institutions that are engaged in providing specialist services, which generally include the acceptance of bills bill s of exchange, corporate finance, portfolio management and other banking services, are known as “Merchant bankers”. FUNCTIONS OF M.B
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.
Corporate Counselling Project Counselling Pre-investment studies Capital Restructuring Credit Syndication and Project Finance Issue management and Underwriting Portfolio management Working capital finance Bill discounting Mergers, amalgamations and takeovers Venture Capital Lease Financing
13. 14. 15. 16. 17.
Foreign Currency Finance Fixed Deposit Broking Mutual Funds Relief to Sick Industries Project Appraisals
REGULATORY FRAMEWORK
The SEBI has the responsibility to protect the interest of the investors in securities, to promote the development of the securities market and to regulate it. To carry out its functions, the SEBI is empowered to make regulations with the prior approval of the Government. The SEBI has now full powers to regulate the new issue/primary market. It is also empowered to impose penalties for default on securities market intermediaries.
The SEBI has laid down the legal l egal framework for the operations of the intermediaries in the primary market as well as the operating instructions and guidelines. The major intermediaries for whom the framework is firmly in place are lead managers, underwriters, bankers to issue, registrars and share transfer agents, debenture trustees, brokers to issue and portfolio managers. The main elements of their operations framework are Compulsory registration, capital adequacy requirement and fee payable; Obligation and responsibilities, code of conduct, number of lead managers, and their responsibilities, due diligence certificate, submission of documents; and Procedure for inspection, action in default, suspension and cancellation of registration.
COMPULSORY REGISTRATION
Category I: To carry on any activity of the issue management and to act as adviser, consultant, manager, underwriter, portfolio manger. Category II: To act as adviser, consultant, co-manger, underwriter, portfolio manager Category III: To act as underwriter, adviser, consultant to an issue Category IV: To act only as adviser or consultant to an issue
CAPITAL ADEQUACY REQUIREMENT Category
Minimum Amount
Category I
Rs. 5,00,00,000 (5 Crore)
Category II
Rs. 50,00,000 (0.5 Crore)
Category III
Rs. 20,00,000 (0.2 Crore)
Category IV
Nil
FEES
Registration Fee Renewal Fee
OBLIGATIONS & RESPONSIBILITIES CODE OF CONDUCT FOR MB – A Merchant Banker should Make efforts to protect interest of investors Maintain high standard of integrity, dignity and fairness in the conduct of its business Fulfill its obligations in a prompt, ethical manner Always exercise due diligence Satisfy the Investors Adequate disclosures are made Not discriminate amongst its client Make no misrepresentation Always render best possible advice to the client Not indulge in any unfair competition Ensure good corporate policies and corporate governance are in place
NEW ISSUE VS. SECONDARY MARKETS OR PRIMARY MARKETS VS. SECONDARY MARKETS MECHANICS OF PUBLIC ISSUE MANAGEMENT
Decision to Raise Capital Funds Obtaining SEBI approval Arranging Underwriting Preparing and Finalization of Prospectus
Selection of Registrars, Brokers, Bankers ,etc Arranging Press and Investor Conference Printing and Publicity of Public Issue Documents SEBI Compliance
CATEGORIES OF SECURITIES ISSUE
Public Issue Right Issue Private Placement
MARKETING OF NEW ISSUES METHODS OF MARKETING SECURITIES
Pure Prospectus Method Offer for Sale Method – Issue House, stock brokers Private Placement Method – Private Individual & inst Initial Public Offer (IPOs) Method Rights Issue Method Bonus Issue Method – Accumulated R&S converted Book-Building Method (Next Slide) Stock-Option Method Bought-out Deals Method – Promoter make outright sale of equity share to sponsor. BOOK-BUILDING METHOD
The B-b process involves the following fol lowing steps 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.
Appointment of book-runners Drafting Prospectus Circulating draft Maintaining offer records Intimation about aggregate orders Bid analysis Mandatory underwriting Filing with ROC Bank accounts Collection of completed application Allotment of securities Payment schedule and listing Under-subscription
ELIGIBILITY NORMS OF PUBLIC ISSUE 1. Public Issue by Unlisted companies
It has net tangible assets of at least Rs.3 crore in each of the preceding 3 full years of which more than 50 % should be in monetary assets It has a track record of distributed profits in terms of Sec.205 of the Companies Act for at least 3 out of the immediately 5 years It has net worth as per the audited balance sheet of at least Rs.1 crore in each of preceding 3 full years (of 12 months each) The aggregate of the proposed issue and all previous issues made in the same financial year in terms of size does not exceed 5 times its pre-issue networth as per the audited balance sheet of the last financial year.
2. Public Issue by Listed Companies
All listed companies are eligible to make public issue of equity shares/securities convertible into, or exchangeable with equity shares at a later date on the condition that the issue size in terms of the aggregate of the proposed issue and all previous issues made in the same financial year does not exceed 5 times its pre-issue networth as per the audited balance sheet of the last year. PRE-ISSUE OBLIGATIONS
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.
Due diligence Requisite fee Submission of documents Appointment of intermediaries Underwriting Making public the offer document Dispatch of issue material No-compliant certificate Mandatory collection centres Authorized collection agents Advertisement for rights post-issues, appointment of compliance officer
POST-ISSUE OBLIGATIONS
1. 2. 3. 4. 5. 6. 7. 8. 9.
To associate with allotment procedure Post issue monitoring reports 3-day post issue monitoring report Final post issue monitoring report (78 days) Redressal of investors grievances Coordination with intermediaries Post-issue advertisements Basis of allotment in over-subscribed issues Other responsibilities
UNIT-III
Leasing and Hire-Purchasing : (a) Leasing concept and classification. Financial rationale. Evolution of leasing industry in India. Product profile. Legal, tax and accounting aspects of leasing in India. Funding and regulatory aspects of leasing in India. Financial evaluation of leasing – leasing – break-even break-even lease rental. Gross yield based pricing. IRR based pricing. Negotiating lease rental. Assessment of lease related risks. Lease vs. buy decisions. (b) Hire-purchase concept and characteristics. Legal and tax framework. Mathematics of hirepurchase. Financial evaluation of hire-purchase deals.
LEASING 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.
Concept of Leasing Definition Leasing as a source of finance Essential elements of leasing Modes of terminating lease Advantage of leasing Disadvantage of leasing Types of leasing Legal aspects of leasing Income tax provisions relating to leasing Accounting treatment of lease
CONCEPT OF LEASING
Leasing, as a financing concept, is an arrangement between two parties, the leasing company or lessor and the user or lessee, whereby the former arranges to buy capital equipment for the use of latter for an agreed period of time in return for the payment of rent. The rentals are pre-determined and payable at fixed intervals of time, according to the mutual convenience of both the parties. By resorting to leasing, the lessee Co. is able to use the economic value of the equipment by using it as he owned it without having to pay for its capital cost.
DEFINITION
Lease is a form of contract transferring use or occupancy of land, space, structure or equipment, in consideration of a payment, usually in the form of a rent. Lease is a contract whereby the owner of an asset (lessor) grants to another party (lessee) the exclusive right to use the asset usually for an agreed period of time in return for the payment of rent LEASING AS A SOURCE OF FINANCE
1. 2. 3. 4.
Modernisation of business Balancing equiment Cars, scooters, and other vehicles and durables Assets which are not being financed by banks/ institutions.
ESSENTIAL ELEMENTS OF LEASING
1. 2. 3. 4. 5.
Parties to the contract Asset Ownership separated from user Term of lease Lease Rentals
MODES OF TERMINATING LEASE
1. The lease is terminated at the end of the lease period and various courses are possible, namely 2. The lease is renewed on a perpetual basis or a definite period, or 3. The asset reverts to the lessor, or 4. The asset reverts to the lessor and the lessor sells it to a third party, or 5. The lessor sells the asset to the lessee 6. The parties may mutually agree to, and choose any of the foresaid alternatives at the beginning of the lease term. ADVANTAGE OF LEASE
1. 2. 3.
Permits alternative use of funds Facilitates additional borrowings Protection against obsolescence
4. 5.
Hundred percent financing Boon to small firms
DISADVANTAGE OF LEASE
1. 2. 3. 4. 5.
Lease is not suitable mode of project finance. Tax benefits/ incentives such as subsidy may not be available on leased equipment The value of asset might increase during lease period Cost of financing is higher than debt financing Default in rentals
TYPES OF LEASE
1. Financial Lease It is also known as capital lease, long term lease, net lease and close lease. In financial lease, the lessee selects the equipment, settles the price and terms of sale and arranges with a leasing company to but it. He enters into non-cancellable contractual agreement with the leasing company. The lessee uses the equipment exclusively, maintains it, insures and avails the after salesservices and warranty backing it. This lease could also be with purchase option, where at the end of the predetermined period, the lessee has the option to buy the equipment at a pre-determined value or at a nominal value or at fair market price. In a large number of cases, the financial f inancial leases are used as financing-come-tax planning tool. The Financial lease is very popular in India as in other countries such as USA, UK, and Japan. In India, at present, around a lease worth Rs.75 to 100 crores is transacted as a tax planning device. The high cost equipments such as office equipment, diesel generators, machine tools, textile machinery, containers, ships, aircrafts, etc are leased l eased under financial lease. In short, in a Financial lease, the lessor transfers to the lessee, substantially substantially all risks and reward incidental to ownership of the asset whether or not the title is eventually transferred. OPERATING LEASE
2. Operating Lease It is also known as service lease, short term lease or true lease. In this lease, the contractual period between lessor and lessee is less than the full economic life of equipment.
This means the lease may be for a limited period such as a month, six months or a year or few years. The risk of obsolescence is enforced on the lessor who will also bear the cost of maintenance and other relevant expenditure. This lease is suitable for – computers, copy machines, vehicles, material handling equipment, etc which are sensitive to obsolescence, and where the lessee is interested in tiding over temporary problem. LEGAL ASPECTS OF LEASING
As there is no separate statute for equipment leasing in India, the provisions relating to BAILMENT in the Indian Contract Act govern equipment leasing agreements. Provisions of Se.148, 150 and 168 have to be fulfilled INCOME TAX PROVISIONS RELATING TO LEASING
The lessee can claim lease rentals as tax-deductible tax -deductible expenses The lease rentals received by the lessor are taxable under the head of “Profits and Gains of Business and Profession”. The lessor can claim investment allowance and depreciation on the investment made in leased assets.
ACCOUNTING TREATMENT OF LEASE
The leased asset is shown on the balance sheet of the lessor Depreciation and other tax shields associated with the leased asset are claimed by the lessor The entire lease rental is treated as income in the books of the lessor le ssor and as expense in the books of the lessee. http://india-financing.com/indo1.html
HIRE PURCHASE
1. 2. 3. 4. 5. 6. 7. 8. 9.
Introduction History of H.P H.P Institutions Features of H.P Legal Position H.P Agreement H.P and Credit sales H.P and Installment sale H.P vs. Leasing
INTRODUCTION
It is a method of selling goods. In Hire Purchase (H.P) transaction the goods are let out on hire by a finance company. The buyer is required to pay an agreed amount in periodical installments during a given period. The ownership of the property remains with wi th creditor and passes on to hirer on the payment of last installment HISTORY OF H.P
The growth and development of H.P system can be traced back to the advent of industrial development in the U.K Henry Moore, a piano maker introduced H.P system in 1846 in the U.K Cowperwait & Sons, a furniture dealer introduced H.P system in U.S.A in 1807. Earlier all H.P transactions were financed by manufacturers or dealers themselves. Later, independent finance house came into existence In India , H.P finance started only after World War I. The concept of H.P was not quite popular in the pre -independence period. With the increase in economic activity, many NBFCs entered the market in the 50s & 60s Wide variety of consumer articles, automobiles and industrial machinery were offered on H.P
Apart from consumer vehicles, purchase of consumer articles such as household appliance, air conditioners, refrigerators, office furniture and equipment is financed presently through hire purchase.
The Indian H.P market is registering a staggering growth rate of around 20 percent per annum.
H.P. INSTITUTIONS
1. The Institutions engaged in the H.P business in organised sector include 2. Commercial Banks 3. Co-operative Banks 4. State Financial Corporations 5. National Small Industries Corporations C orporations 6. In the unorganised sector they comprise a large number of partnership firms and individuals.
FEATURES OF HIRE PURCHASE
1. Buyer takes possession of goods immediately and agrees to pay total price in installments. 2. Each installment is treated as hire charges 3. The ownership of goods passes from the seller to the buyer on the payment of the installment. 4. If buyer makes default in the payment of any installment, the seller has right to repossess the goods from the buyer and forfeit the amount already received treating it as hire charged 5. The hirer has right to terminate the agreement any time before the property passes. LEGAL POSITION
The Hire Purchase Act,1972 defines a Hire Purchase as “an agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of agreement as under 1. Payment is to be made in installments over a specified period. 2. The possession is delivered to the purchaser at the time of entering into a contract 3. The property in the goods passes to the purchaser on payment of the last last installment.
4. Each installment is treated as hire charge so that if default is made in payment paymen t of anyone installment, the seller is entitled to take away the goods. 5. The hirer/purchaser is free to return the goods without being required to pay further installments falling due after the return
HIRE PURCHASE AGREEMENT
1. The description of goods in a manner sufficient to identity them 2. The H.P price of the goods 3. The date of commencement of the agreement 4. The number of installments in which H.P price is to be paid, the amount, and due date H.P & CREDIT SALE
Hire purchase is different from Credit Sale In credit sale, the ownership and possession is transferred to the purchaser simultaneously. In H.P, the ownership remains with the seller until last installment is paid
H.P & INSTALLMENT SALE
H.P transaction is different from Installment System (I.S). In case of I.S the possession and ownership is transferred to the buyer immediately. When the buyer stops payment of dues (installments), the seller has no right to repossess the goods.
He has the only right to sue the buyer for the non-payment non -payment by returning the goods.
HP Vs. LEASING
CHARACTERISTICS
LEASING
HIRE PURCHASE
Ownership
It rests with lessor
It is transferred on payment of last installment installmen t
Depreciation Depreciation
Lessor, not the lessee is entitled to claim
The hirer is entitled to claim
Tax Benefits
Lease rent is tax deductible deductibl e
Interest of H.P installment is tax deductible deductibl e
Salvage Value
It can be claimed by the lessor & not the lessee
It can be claimed by the hirer as he is the owner
Down Payment
Not required
It is required to the extent of 20 to 25% of margin.
Reporting
Shown in foot note only
In Balance sheet as asset
UNIT – IV
Insurance: Definition and basic characteristics of insurance. Requirements of an insurable risk. Types of insurance. Benefits and Costs of insurance to society. Fundamental legal principles of insurance. Functions of insurer. IRDA and recent trends in insurance sector in India.
INSURANCE 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
INTRODUCTION DEFINITION INSURANCE VS. M.F ROLE OF INSURANCE IN ECONOMIC GROWTH HISTORY OF INSURANCE HISTORY OF INSURANCE IN INDIA OPENING UP OF THE INDIAN INSURANCE SECTOR IRDA – INTRODUCTION IRDA – MISSION IMPORTANT WEBSITES – INSURANCE
INTRODUCTION
An age-old method of sharing of risk through economic cooperation led to the development of the concept of Insurance. Insurance spreads the risks and losses of few people among a large number of people, as people prefer small fixed liability instead of big uncertain and changing liability. The risks which can be insured against include fire, the perils (damage) of sea, death, accident, and burglary. The members of the community subscribe to a common pool or fund which is collected by the insurer to indemnify the losses arising out of risks. Insurance cannot cannot prevent the occurrence but it provides for the losses of risk. It is a scheme which covers large risks by paying small amount of capital. Insurance is also a means of savings and investment
Example
1. In a town, there are 2,000 persons who are all aged 60 and are healthy. It is expected that of these, 20 persons may die during the year. If the economic value of the loss suffered by the family of each dying person were taken to be Rs.50,000, the total loss would work out to Rs.10,00,000. If each person of the group contributes Rs.500 a year, the common fund would be of the 20 dying persons. Thus, the risks in cases of 20 persons are shared by 2000 persons. 2. In a village, there are 250 houses, each valued at Rs.2,00,000. Every year one house gets burnt, resulting into a total loss of 2,00,000. If all the 250 owners come together and contribute Rs.800 each, the common fund would be Rs.2,00,000. This is enough to pay Rs.2,00,000 the owner who’s house got burnt. Thus, the risk of one owner is spread over 250 house-owners of the village. DEFINITION
Insurance can be defined as legal contract between two parties whereby one party called the insurer undertakes to pay a fixed amount of money on the happening of a particular event, which may be certain or uncertain. The other party called the insured pays in exchange a fixed sum known as premium.
The insurer and the insured are also known as assurer, or underwriter, and assured, respectively. The document which embodies the contract is called the policy.
INSURANCE Vs M.F
Insurance and mutual funds are fundamentally different in their objectives. The objective of insurance is to cover the eventuality of death and therefore, is more long-term in its outlook while, mutual funds are purely investment gain vehicles
ROLE OF INSURANCE IN ECONOMIC GROWTH
Insurance frees industries from the worries of unforeseen losses and uncertainties. Insurance Insurance helps the process of the country’s growth in various ways 1. Insurance covers many economic risks. It protects entrepreneurs against the risk of damage to or loss of the goods and other assets, which they employ in manufacturing, marketing, transport and other related activities. This protection offers a kind of stability to business. 2. With the cover of insurance on their assets, businessmen and industrialists industrialists are able to take bold decisions in enlarging their field of activity, and take financial risks, which they cannot otherwise take. Hence, insurance plays a promotional role in nationalbuilding and also increasing the number of jobs for the people. 3. Life insurance offers economic safety at reasonable cost to millions of families in in the country. In a way, this helps the government also as it lightens the government’s burden of providing social welfare to affected families 4. Insurance companies collect premium from policyholders and invest this money in government bonds, corporate securities and other approved channels of investment. In this way, insurance companies are helpful in providing capital for new ventures or expansion of old units.
Thus insurance aids in the growth of modern economy. By promoting safety against personal losses it not only i mproves the individual’s quality of life but also provides smoothness in the working of affairs of business and industry.
HISTORY OF INSURANCE
The concept of insurance is believed to have emerged almost 4,500 years ago in the ancient land of Babylonia where traders used to bear risk of the caravan by giving loans, which were later repaid with interest when the goods arrived safely. The first insurance contract was entered into by European nations in 1347 to accept marine insurance as a practice The concept of insurance as we know today took shape in 1688 at a place called Lloyd’s Coffee House in London where risk bearers used to meet to transact business.
This coffee house became so popular that Lloyd’s became the one of the first modern insurance companies by the end of the eighteenth century. The Great Fire of London in 1966 caused huge loss of property and life. With a view to providing fire insurance facilities, Dr. Nicholas Barbon set up in 1967 the first fire insurance company known as the Fire Office. The oldest life insurance company in existence today is the Society for the Equitable Assurance of Lives and Survivorship, known as “Old Equitable”. It was established in England in 1756. The infamous New York Fire and the great Chicago Fire in 1835 and 1871, respectively, created an awareness and need for insurance. The concept of re-insurance emerged to deal specifically for such situations. Industrialisation and urbanisation popularised the concept of insurance insurance and growth in insurance led to the development of new insurance products.
HISTORY OF INSURANCE IN INDIA
The early history of insurance in India can be traced back to the Vedas. Some form of ‘community insurance’ was practiced by the Aryans around 1000 B.C. Life insurance in its modern form came to India from England in 1818.
The Oriental Life Insurance Company was the first insurance company to set up in India to help the widows of the European community. The first Indian insurance company, the Bombay Mutual Life Assurance Society, came into existence in 1870 to cover Indian lives. Moreover, in 1870, the British Government enacted for the first fi rst time the Insurance Act,1870. Other companies, such as the Oriental Government Security Life Assurance Company, the Bharat Insurance Company, and the Empire of India Life Insurance Company Limited, were set up between 1870 and 1900. In 1912, the first legislation regulating insurance, the Life Insurance Companies Act,1912, was enacted. By the mid 1950s, there were 154 Indian insurers, 16 foreign insurers, and 75 provident societies carrying on life insurance business in India The Life Insurance Corporation of India (LIC) was set up in 1956 to take over 245 life companies. The nationalisation of life insurance was followed by general insurance in 1972. The General Insurance Corporation of India and its subsidiaries were set up in 1973.
OPENING UP OF THE INDIAN INSURANCE SECTOR
The Insurance industry till august 2000 had only two nationalised players: LIC and GIC. These two players had a monopolistic control over the market. These nationalised insurance companies performed well BUT were not consumeroriented, unwilling to adopt modern practices practices and technology to upgrade technical skills, and inefficient in operations. The growth in volume was mainly driven by income tax consideration and hence a major portion of the vast rural area was untapped. With population of more than one billion and savings rate of around 24%, India has a vast market which is untapped. The foreign insurance companies’ external influence and pressure to open up the Indian insurance sector was high. In 1993, the committee under the chairmanship of R.N. Malhotra, set up to evaluate the Indian Insurance Industry and recommend its future direction, submitted its report in 1994. Its major recommendations revolved around the structure and regulation of insurance industry. The main recommendations recommendations were as follows: o The government should bring down its stake in the insurance companies to 50% o Private companies with a minimum paid-up capital of Rs.100 crore should be allowed to enter the industry o The number of entrant should be controlled o Foreign companies may be allowed to enter industry in collaboration with domestic companies. The committee did not favour foreign companies operating in India through branches.
o The GIC and its subsidiaries should not hold more than 5 percent in any company. INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (IRDA)
IRDA was constituted as an autonomous body to regulate and develop the business of insurance and reinsurance in India. The IRDA Act, 1999 was enacted by parliament in the fiftieth year of the Republic India to provide for the establishment of an authority to protect the interests of holders of insurance policies, to regulate, promote and ensure orderly growth of the insurance industry. The Act was approved in the parliament in December 1999 and the insurance sector was opened for private licensees on 15 August 2000.
IRDA – MISSION
1. To protect the interest of and secure fair treatment to policyholders 2. To bring about speedy and orderly growth of the insurance industry 3. To set, promote, monitor, and enforce high standards of integrity, financial soundness, fair dealing, and competence of those it regulates. 4. To ensure that insurance customers receive precise, clear and correct information about products and services and make them aware of their responsibilities and duties in this regard. 5. To promote fairness, transparency, and orderly conduct in financial markets dealing with insurance and to build a reliable MIS to enforce high standard of financial soundness amongst market players. 6. To take action where such standards are inadequate or ineffectively enforced. IMPORTANT WEBSITES
http://en.wikipedia.org/wiki/Insurance http://www.irdaindia.org/ http://economictimes.indiatimes.com/Perso http://economictimes.indiatimes.com/Personal_Finance/Insura nal_Finance/Insurance/Analysis/Indian nce/Analysis/Indian_general_in _general_in surance_industry_to_grow_at_18_in_2008/articleshow/3120969.cms http://www.insurancejournal.com http://www.insurancejournal.com/news/international /news/international/2008/02/08/87186.htm /2008/02/08/87186.htm http://www.licindia.com/
http://www.economywatch.c http://www.economywatch.com/indianeconomy/india om/indianeconomy/indian-insurance-industry.htm n-insurance-industry.htmll (Good) http://www.cerc.com/pdfs/insurance.pdf http://www.webpages.ttu.edu http://www.webpages.ttu.edu/sbaugues/fin3323/11.% /sbaugues/fin3323/11.%20Insurance.p 20Insurance.pdf df http://www.aspira.org/ins_new/auto% http://www.aspira.org/ins_new/auto%20pdfs/auto_teen_rev.p 20pdfs/auto_teen_rev.ppt pt http://www.lifeinscouncil.org/presenta http://www.lifeinscouncil.org/presentations/Indian%20Life%20I tions/Indian%20Life%20Insurance%20Ind nsurance%20Industry%20and% ustry%20and% 20Taxation.pdf http://www.lifeinscouncil.org/presenta http://www.lifeinscouncil.org/presentations/Contribution%20of%20Life%2 tions/Contribution%20of%20Life%20Insurance% 0Insurance%20Sect 20Sect or%20in%20the%20Economy.pdf http://www.ficci.com/media-room/speech http://www.ficci.com/media-room/speeches-presentations/2004/oc es-presentations/2004/oct/indiant/indianinsurance/Janmejaya_Sinha%20.ppt http://www.actuaries.jp/eaac14 http://www.actuaries.jp/eaac14th/pdf/session/01S_Su th/pdf/session/01S_SubrahmanyamK.p brahmanyamK.pdf df http://www.ifc.org/ifcext/che.nsf/Attac http://www.ifc.org/ifcext/che.nsf/AttachmentsByTitle/Healthpres_2007_Deep hmentsByTitle/Healthpres_2007_DeepakMendiratta/$F akMendiratta/$F ILE/Healthpres_2007_Deepak+Mendiratta.pdf http://www.researchandmarkets. http://www.researchandmarkets.com/reports/313125/indian_in com/reports/313125/indian_insurance_industry_a surance_industry_an_analysis. n_analysis. pdf http://www.guycarp.com/portal/extra http://www.guycarp.com/portal/extranet/pdf/ExtPub/Clive_Baker_June_2004. net/pdf/ExtPub/Clive_Baker_June_2004.pdf pdf http://business.mapsofindia.com/insurance/ http://www.ficci.com/media-room/speech http://www.ficci.com/media-room/speeches-presentations/2004/oc es-presentations/2004/oct/oct18-ins-csrao.htm t/oct18-ins-csrao.htm http://unpan1.un.org/intradoc/gro http://unpan1.un.org/intradoc/groups/public/doc ups/public/documents/apcity/unpa uments/apcity/unpan002873.pdf n002873.pdf http://www.icra.in/aspx/Insuran http://www.icra.in/aspx/Insurance-ICRA-Moodys-200704.pdf ce-ICRA-Moodys-200704.pdf http://www.pri-center.com/document http://www.pri-center.com/documents/south_south/In s/south_south/India.pdf dia.pdf http://www.indiaprwire.com/pressrelea http://www.indiaprwire.com/pressrelease/insurance/200701091526.htm se/insurance/200701091526.htm http://www.ifc.org/ifcext/enviro.nsf/Content/I http://www.ifc.org/ifcext/enviro.nsf/Content/InsuranceServices_Highlight nsuranceServices_Highlights_Delhi s_Delhi http://www.indiainsuranceresearc http://www.indiainsuranceresearch.com/lifeinsurance_u h.com/lifeinsurance_update/AnnualBusines pdate/AnnualBusinessReview2005_06 sReview2005_06 .pdf http://www.nottingham.ac. http://www.nottingham.ac.uk/business/cris/papers/200 uk/business/cris/papers/2002-10.pdf 2-10.pdf (Good) http://www.indianembassy.org/enew http://www.indianembassy.org/enews/econews(dec99). s/econews(dec99).pdf pdf http://www.expresshealthcaremgmt. http://www.expresshealthcaremgmt.com/20041015/conversa com/20041015/conversation02.shtml tion02.shtml http://newdelhi.usembassy.gov/amboct062005.html http://more4you.ws/articles/launch/02-11-2006Futu http://more4you.ws/articles/launch/02-11-2006Future-of-Indian-Insuran re-of-Indian-Insurance-Industryce-IndustryCompletely-Insured-.htm http://www.welcome-nri.com/Industryr http://www.welcome-nri.com/Industryreport/Insuranc eport/Insurancereport.htm ereport.htm http://www.welcome-nri.com/Industryr http://www.welcome-nri.com/Industryreport/Insuranc eport/Insurance7.htm e7.htm http://www.welcome-nri.com/Industryr http://www.welcome-nri.com/Industryreport/Insuranc eport/Insurance8.htm e8.htm
http://www.welcome-nri.com/Industryr http://www.welcome-nri.com/Industryreport/Insuranc eport/Insurance9.htm e9.htm
UNIT – V
Other financial services: (a) Factoring and bill discounting concept, process and forms. Functions of a factor. Legal aspects of factoring and bill discounting. Financial evaluation of factorial services – services – cost cost of factoring – factoring – decision decision analysis for factor services. Factoring scenario in India. (b) Credit rating concept and utility. Credit rating agencies in India and their performance. Financial dimensions of crediting rating methodology. Types of ratings and symbols.
FACTORING The word “Factor” has been derived from the Latin word “Facere” which means “to make or to do”. Factoring, basically involves transfer of the collection of receivables and the related book-keeping functions from the firm to a financial intermediary called the factor. Factoring provides the firm with a source of financing its receivables and facilitates the process of collecting the receivables.
FUNCTIONS OF A FACTOR
1. Purchase and collection of debts 2. Sales ledger management 3. Credit investigation and undertaking of credit risk 4. Provision of finance against debts 5. Rendering consultancy services FORMS OF FACTORING
1. Recourse and Non-recourse factoring 2. Advance and Maturity factoring 3. Full Factoring 4. Disclosed and Undisclosed factoring 5. Domestic and International factoring
COST OF FACTORING
Finance Charge
It is computed on the payment outstanding in the client’s account at monthly intervals. Finance charges are only for financing that has been availed. These charges are similar to the interest levied on the cash credit facilities in a bank.
Service Fee
It is a nominal charge levied at monthly intervals to cover the cost of services such as collection, sales ledger management, and periodical MIS reports. Service fee is determined on thee basis of criteria such as the gross sales value, the number of customers, the number of invoice and credit notes, and the degree of credit risk represented by the customer or the transactions.
ADVANTAGES OF FACTORING 1. Cost Savings – reduction in administrative cost 2. Liquidity – Promotes efficient WC mgt
3. 4. 5. 6. 7. 8. 9.
Credit Discipline Cash Flows Prompt payment Boon to SSI sector – helps in financing WC Efficient Production Reduced Risk Export Promotion
FACTORING IN INDIA
Factoring is of recent origin in the Indian context and is still in a nascent stage. According to the recommendation of the Kalyanasundaram Committee,1988, RBI amended the Banking Regulation Act and permitted subsidiaries of banks to start factoring companies FACTORING OBSTACLES IN INDIA INDIA
Factoring deals in India encounter serious obstacles which stand in the way of growth of such services –
1. Lack of specialised credit information agency 2. Legal hassles 3. Funding Limitations 4. Limited coverage
If factoring is to grow, a solution to these problems is urgently needed IMPORTANT WEBSITES
http://en.wikipedia.org/wiki/Factoring_(finance) http://www.languages.ind.in/fac http://www.languages.ind.in/factoring.htm toring.htm (GOOD) http://www.euindiachambers.com http://www.euindiachambers.com/Events/HSBC-India.pdf /Events/HSBC-India.pdf http://www.bized.co.uk/learn/acco http://www.bized.co.uk/learn/accounting/financia unting/financial/sources/factor.htm l/sources/factor.htm http://www.1stcommercialcredit.com/ http://www.factoringfinance.org/ http://www.factoring.ru/eng/commercial/finance/ http://www.ocf.com/factoring/fact http://www.ocf.com/factoring/factoring-financial-services.htm oring-financial-services.htm http://www.factoringhouse.com/index1.htm http://www.hsbc.co.in/1/2/business/factoring-solutions http://www.thehindubusinessline.co http://www.thehindubusinessline.com/2008/06/10/stories/20080610509 m/2008/06/10/stories/2008061050910600.htm 10600.htm http://www.jcrenterprise.com/factoring_a http://www.jcrenterprise.com/factoring_accounts_receivable_in ccounts_receivable_india.htm dia.htm http://lnweb18.worldbank.org/ECA/eca.nsf http://lnweb18.worldbank.org/ECA/eca.nsf/abdf2b83e74f58ef852567d1 /abdf2b83e74f58ef852567d10011a8ba/3d06c90df9 0011a8ba/3d06c90df9 4b22e685256dca007be1b7/$FILE/World%20Bank% 4b22e685256dca007be1 b7/$FILE/World%20Bank%20GTF%20Case%20Stu 20GTF%20Case%20Study.ppt dy.ppt http://www.pharmexcil.com/v1/docs/5_Ms http://www.pharmexcil.com/v1/docs/5_MsShrutiSingh_Global_Trade_Finan ShrutiSingh_Global_Trade_Finance_Ltd.pdf ce_Ltd.pdf
http://www.ficci.com/media-room/speech http://www.ficci.com/media-room/speeches-presentations/2003/Feb/ es-presentations/2003/Feb/feb7-dupontfeb7-dupontamitmitra.ppt
CREDIT RATING
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.
INTRODUCTION TO CREDIT RATING (C.R) DEFINITION OF C.R HISTORY OF C.R REASONS FOR GROWTH OF C.R SYSTEM GROWTH OF C.R AGENCIES WORLDWIDE FUNCTIONS OF C.R ESSENTIALS OF RATING SERVICE BENEFITS OF C.R BENEFITS TO RATED COMPANIES CREDIT RATING IN INDIA RATING PROCESS RATING METHODOLOGY RATING SYMBOLS
INTRODUCTION
As the number of companies borrowing directly from the capital market increases, and as the industrial environment becomes more and more competitive and demanding, investors find that borrower’s net worth or name are no longer sufficient to ensure successful raising of funds from the market. In such a scenario, to enable the investors to take informed decisions, Credit Rating has emerged as one of the most important financial services. A Credit rating is not a general evaluation of the issuing organisation. It essentially reflects the probability of timely repayment of principal and interest by a borrower company. DEFINITION
According to Moody’s Investor Service (USA) “Rating is designed exclusively for the purpose of grading bonds according to their investment qualities”. According to Credit Rating Information Services of India Ltd. (CRISIL) “Credit rating is an unbiased, objective and independent opinion as to issuer’s capacity to meet its financial obligations. It does not constitute a recommendation to buy/sell or hold a particular Security” HISTORY
The concept of credit rating dates back to 1840s Mercantile Credit Agency (MCA) was set up in New York after the financial crisis of 1837. The agency (MCA) rated the ability of merchants to pay their financial obligations. The first rating guide was published in 1859. In 1909, John Moody founded Moody’s Investors Agency, which gave a new direction to the concept of credit rating.
In 1970, Penn Central, the then largest Railroad company in the world went bankrupt with just under $100 million in outstanding commercial paper. This forced the investors to ask for rating for commercial papers Today, almost 100% of the commercial paper and 99% of the corporate bond are rated in the U.S.A
REASONS FOR GROWTH OF C.R SYSTEM
1. 2. 3. 4.
The increasing role of capital and money markets Increase in corporate borrowing and lending The continuing growth of Information Technology The growth of confidence in the efficiency of the market functioning
GROWTH OF CREDIT RATING AGENCIES AGEN CIES WORLDWIDE Missing info FUNCTIONS OF CREDIT RATINGS
1. 2. 3. 4. 5.
Superior Information Low Cost Information Proper risk-return trade off Healthy discipline on Corporate Borrowers Formulation of public policy guidelines on institutional investment
ESSENTIALS OF RATING SERVICE
Critical investment decisions may be taken based on the ratings offered by the credit rating agency. In order to ensure that ratings lead to good investment decisions it is essential that the rating service has the following two important factors – 1. The quality of rating should be such that it wins the confidence and trust of the users of such ratings 2. Rating agencies should be unbiased to both the investors and the corporate. BENEFITS OF CREDIT RATING
1. 2. 3. 4.
Low cost information Quick investment decision Independent investment decision Investors protection
BENEFITS TO RATED COMPANIES
1. 2. 3.
Sources of additional certification Increase the investors population Fore-warns risks
4. 5. 6. 7. 8. 9.
Encourages financial discipline Merchant bankers job made easy Foreign collaboration made easy Benefits the industry as a whole Low cost of borrowing Rating as a marketing tool
CREDIT RATING IN INDIA
The stupendous growth of Indian Capital Market necessitated setting up of Credit rating agencies in India. As the average size of debenture issued by the company, the number of companies issuing debentures and the number of investors were growing substantially, the need for establishment of independent credit rating agency was felt in the country This growth led the establishment of 1. 2. 3.
Credit Rating Information Services of India Limited (CRISIL) in 1987. Investment Information Information and Credit Rating Agency of India (ICRA) in i n 1991 Credit Analysis and Research Limited (CARE) in 1993.
All the three credit rating agencies have been approved by the Reserve Bank of India. CRISIL
It is the first credit agency started on January 1,1988 It was started jointly by ICICI and UTI with an Equity Capital of Rs.4 crores It is the most important rating agency in the country. Its major objective is to rate the debt obligations of Indian Companies Apart from rating debentures, commercial papers, LPG/Kerosene dealers, its rating services also extend to preference shares, real estate developers/builders, banks, etc. Its rating guides investors about the risk of timely payment of interest and principal on particular debt instrument. It has used its information base and expertise in credit rating to provide counselling to governments, banks, financial institutions on aspects such as privatization of PSUs, credit evaluation and so on.
ICRA
It was set up by IFCI on 16 th Jan’1991 It focuses on rating of instruments for which credit rating is mandatory, suhc as debentures/bonds, debentures/bonds, commercial papers, Kerosene/LPG dealers.
It also rates banks It also provides credit assessment and general assessment services During 1994-95, ICRA rates 212 debt instruments covering a debt volume of Rs.5,343 crores. The cumulative number of instruments rated since its inception till March 1995 has been 485 covering a total debt volume of Rs.17,638 crores.
CARE
It is credit rating and information services company promoted by IDBI jointly with investment institutions, banks, and fianance companies. It commenced its credit rating operation in October’1993. CARE is offering a wide range of products & services in the fields of credit information and equity research. CARE confines to normal rating business only and has not diversified its operations the instruments credit-rated by CARE are debentures, Fixed deposits, Commercial papers, etc CARE also undertakes general general credit analysis of companies for the use of bankers, bankers, other lenders and business counterparties CARE’s rating methodology and rating process are much similar to CRISIL Since its inception till the end of March 1995, CARE has rated249 instruments covering a total debt volume of Rs.9,729 crores.
RATING PROCESS
The credit rating process adopted by leading credit rating agencies in India and the world over is depicted below 1. Contract between Rater and Client 2. Sending expert team to client’s Place 3. Data collection 4. Data analysis 5. Discussion 6. Credit report preparation 7. Submission to “grading committee” 8. Grade communication to client RATING METHODOLOGY
In India, the rating exercise starts at the request of the company the process of obtaining a rating is quite lengthy and time consuming. Ratings are assigned after an in-depth study of various factors related to Business, Financial Management, and so on. The analytical framework for rating consists of the following four broad areas. 1.
Business Analysis
2. 3. 4.
Financial Analysis Management Evaluation Fundamental Analysis
1. Business Analysis
Industry Risk Market Position Operating Efficiency Legal Position
2. Financial Analysis
Accounting Quality Earnings Protection Cash Flow Adequacy Financial Flexibility
3. Management Evaluation Study of the track record Management’s capacity capacity to overcome adverse or negative situations Goals Philosophy, and Strategies
4. Fundamental Analysis Liquid management Asset management Profitability and interest Tax sensitivity
RATING SYMBOLS
Since the rating of the agencies will be used by lay investors, the outcome of the rating should be delivered in an understandable manner. To facilitate the rating, symbols are provided These rating symbols can be easily understood by investors and enable them to take decisions on investments. The investor will not have to wholly depend on the broker’s advice as the rating symbols gives a clue to the credibility of the issuer. CRISIL – Fixed Deposit Rating Symbols
